Bitcoin: Currency or commodity?

Last fall we saw bitcoin receive an unusual amount of attention. The upstart crypto currency had an exponential rise from $125 to more than $1,125 per unit on Bitstamp, only to fall back below $500 this spring (see “It’s a $, it’s a €, it’s cryptocurrency,” right). Additionally, the closing and bankruptcy of the Tokyo-based Mt. Gox (the largest bitcoin exchange with more than 600,000 customers) garnered substantial negative press and threatened the stability of bitcoin.

In stark contrast, bitcoin also has received a great deal of positive attention within the venture capital community. Cameron and Tyler Winklevoss (the Winklevoss twins of Facebook fame) have filed to register the Winklevoss Bitcoin Trust, which will be an exchange-traded fund (ETF) to invest and trade in bitcoin. And Paypal co-founder Peter Theil has invested in BitPay, a bitcoin payment solutions company. As a result, bitcoin is becoming the new darling and target of early mover capital investment with more than $200 million in publicly disclosed 2014 VC investments.

It’s important to understand that bitcoin is a global phenomenon. There are 434 bitcoin meet-up groups, with 45,751 members in 309 cities and 68 countries (www.bitcoinmeetup.com), and there are estimated 500,000 to 1 million U.S. digital currency accounts. The bitcoin e-commerce economy is emerging with the offering of bitcoin online payment solutions connecting customers to merchants.

Leading brands such as Zynga, Square and Overstock are all accepting bitcoin. Bitcoin ATMs are now appearing in multiple countries. Let’s focus on this: It’s a currency, that in trading, is emerging as a market of its own. Ilya Subhkankulove, founder of Bitcoin trading platform BTX Trader LLC, anticipates growth in the next three years of as high as 20 times its current size. Even Bloomberg has begun to cover bitcoin price action. A recent story noted, “While bitcoin and other virtual currency markets are still nascent, they represent an interesting intersection of finance and technology. Given that Bloomberg sits squarely at that intersection, providing pricing for this underdeveloped market is a natural fit for us.”

Time to take a good look at bitcoin

Wikipedia defines bitcoin as: A peer-to-peer payment system introduced as open source software in 2009 by developer Satoshi Nakamoto. The digital currency created and used in the system is also called bitcoin and is alternatively referred to as a virtual currency or crypto currency.

Is bitcoin a currency or commodity? The short answer is that it’s both. From a user’s behavioral point of view, bitcoin was designed as a means of exchange. Those who buy bitcoin either look to hold it and sell at higher level, or use it to exchange it for a good or service from a retail merchant. In this sense, bitcoin acts as an alternative currency. Whether bitcoin is a reliable store of value remains the risk to those who buy it.

One’s definition of bitcoin may not be as important as the regulators’ definition. Global regulators are just beginning to define and develop regulations for bitcoin and other related virtual instruments. For example, Germany has defined them as private money and a financial instrument; Denmark considers bitcoin neither a currency nor an asset. In the United States, the IRS issued its opinion on how virtual currencies/bitcoin would be treated. For federal tax purposes, virtual currency is treated as property.

How is bitcoin generated and acquired? Bitcoin ownership is not identified or established by name, but by the use of a private key linked to the blockchains. Therefore, no authority can flood the world with more bitcoins because the process of generating them, called mining block chains, is a function of a very complex algorithm. This algorithm is such that when each bitcoin is created, it is exponentially more difficult to create or mine than the previous bitcoin. This means that the rate of supply of bitcoin globally will decline until the total is reached. The total amount of bitcoins in the world will be limited by this algorithm to 21 million; there are now about 12.7 million bitcoins. This technology of encoding the ownership of bitcoin is being regarded as ushering in an era of the digitization of potentially anything.

Libertarians and anarchists, who want no central authority involved in the role of money, are the leading champions of bitcoin and similar alternative currencies. In fact, the term crypto-anarchists has emerged to label this political philosophy.

About the Author

Abe Cofnas is author of “Sentiment Indicators” and “Trading Binary Options: Strategies and Tactics” (Bloomberg Press). He is editor of binarydimensions.com newsletter and can be reached at abecofnas@gmail.com.